ECN 212: Microeconomic Principles - Final Exam Study Guide
ECN 212: Microeconomic Principles - Final Exam Study Guide ECN 212
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This 10 page Study Guide was uploaded by Gwen on Sunday May 1, 2016. The Study Guide belongs to ECN 212 at Arizona State University taught by Dr. Nancy Roberts in Spring 2016. Since its upload, it has received 124 views. For similar materials see Microeconomic Principles in Economcs at Arizona State University.
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Date Created: 05/01/16
ECN 212 Final Exam Study Guide A good economist thinks with their head and not their heart. Week 1: Opportunity Costs, Demand (Exam #1, Homework #1) ● nothing ifree ● normative vs. positive statements ○ positive statements can be tested, normative statements are opinion based Ex: Higher taxes on cigarettes are good because they discourage people from buying cigarettesis a normative statement. → who is to say what is ‘good’ or ‘bad’? ● in order to analyze a problem, you have to look at both the costs and the benefits. ○ ‘costs’ don’t always have a price tpportunity cos(OC) involve the loss of potential gain from alternatives when another alternative is chosen. Ex: if you buy a salad for lunch, the OC includes the loss of happiness you might have felt if you bought a burger instead. ● In a good market economy, there are: 1. welldefined property rights → what’s yours is yours, what’s mine is mine. 2. incentives → people rationalize decision making ● DecisionMaking Assumptions: 1. selfinterest hypothesis: people act in their own best interest Ex: Mother Teresa helped people in Indecause she liked it 2. ceteris paribus (CP): everything else is held constant when testing 2 variables Ex: When testing to see how enrollment would be affected if ASU were to raise tuition, ONLY enrollment and tuition should be considered; all other factors should be ignored. 3. cause/effect fallacy: just because 2 things happen together, doesn’t mean one caused the other Ex: In 2000, bankruptcy went up 10x and tubing tripled → how could these two events possibly be related? 4. fallacy of composition: just because something is true for one part, doesn’t mean it’s true for the whole Ex: if everyone showed up to class every day and studied for 2 hours a night, not everyone is guaranteed an A in the class. ● Production Possibilities Curve (PPC) ○ represents what a producer can produce when they exert all their resources and all of their technology ■ anything outside the curve, the producer doesn’t have enough resources to produce. ■ anything inside the curve, the producer isn’t using all of their resources (and can/should produce more!) ○ number of resources (including capital, labor, technology, etc.) affects the size of a producer’s PPC ■ an increase in resources causes an expansion of their PPC ■ a decrease in resources causes the PPC to shrink ● Demand is a consumer phenomena, based on the preferences of consumers despite what a producer is actually able to create. ● consumers want to maximize utility (happiness) ● Law of Demand: as price of a product increases and everything else is held constant (CP), quantity demanded decreases (and vice versa) Ex: if the price of your favorite cereal increased by three times as much, would you still be willing to buy it? ● Determinants of Demand 1. population 2. income a. normal goods → a good whose demand increases because of an increase in income; determined by the individual b. inferior goods → a good whose demand decreases because of an increase in income; determined by the market Ex: College students buy ramen noodles because they’re cheap. If students have an increase in income, they’d be more likely to buy more mac ‘n’ cheese, which is more expensive. This would cause a decrease in the demand for ramen noodles. In this scenario ramen would be anferiorood, and mac ‘n’ cheese would be a normal ood. 3. tastes/preferences 4. consumers’ expectations Ex: If the government announced they were to increase the sales tax on Mercedes cars in a month, the demand for Mercedes cars would increase in that month because of the expectation that after that month, the car would cost much more. 5. changes in the price in the price of: a. substitute goods → goods that can be bought in place of another Ex: If the price of Coke went up, Qd would decrease and some of those consumers would buy a substitute like Pepsi instead b. complementary goods → goods that are bought to be used with another Ex: If the price of tennis balls increased, people would stretch out the life of their rackets and the demand for rackets would decrease. ● movement between two points on a demand curve is considered a change in quantity demanded → only affected by price ● movement of the entire curve is considered a change in demand → affected by all other determinants Week 2: Supply, Equilibrium (Exam #1, Homework #1) ● Supply is a producer phenomena, based on what a producer is able to create, despite the preferences of consumers. ● producers want to maximize profits ○ not greedy! → without profits, there would be no production ● Law of Supply: as price increases, and everything else is held constant (CP), quantity supplied increases (and vice versa) Ex: as price increases, producers earn more profits, thus are able to spend more money to create more output. ● Determinants of Supply 1. number of suppliers 2. price of inpu (resource labor, technology, capital, etc.) 3. technology 4. change in price of a related good (substitute/complementary goods) Ex: If oats turn up a bigger profit, some wheat farmers will switch to oats, causing a decrease in supply. 5. producers’ expectations ● the point where the demand curve crosses the supply curve is the market’s equilibrium ○ represents the optimal price consumers are willing and able to pay and the optimal quantity producers can supply ○ “clears the market” → no surplus, no shortage ● consumer’s surplus (CS) occurs when a consumer pays less for a product than they value it (area on the graph between the equilibrium price and the demand curve) ● producer’s surplus (PS) occurs when a producer sells a product for more than they value it (area on the graph between the equilibrium price and the supply curve) ● Things that can ruin a market equilibrium: ○ a price ceiling is when the government imposes a max. price a good can be exchanged between buyer and seller (meant to help consumers, so that producers don’t “overcharge”) ○ a price floor is when the government imposes a minimum price producers and consumers can exchange a good (meant to help producers, so that consumers don’t “underpay”) Week 3/4: Elasticity, Consumer Choice (Exam #1, Homework #2) ● elasticity represents the market’s sensitivity to price, therefore it depends on the good ○ elastic graphs = more responsive, elastic graphs = less responsive ○ a perfectly inelastic graph would be vertical ● What Determines Elasticity 1. Number of substitutes → the greater the number, the greater the elasticity 2. luxury vs. necessity (how much the consumer needs the item) 3. portion of a person’s budget the item consumes 4. time ● 4 Measures of Elasticity 1. price elasticity of demand a. between 0 and 1 = inelastic, between 1 and infinity = elastic (always negative) Ex: a 1% change in price will cause a 1.31% change in demand in the opposite direction 2. price elasticity of supply a. between 0 and 1 = inelastic, between 1 and infinity = elastic (always positive) Ex: a 1% change in price will cause a 3.2% change in supply in the same direction. 3. income elasticity of demand 4. cross price elasticity ● Law of Diminishing Marginal Utility (MU): the more you consume something, the less happiness you’ll get from each item ● Consumers determine what to buy based on their MU they’ll receive per dollar (MU/P) ● Consumer equilibrium: when two items are worth the same amount to a consumer ○ To calculate consumer equilibrium: M ÷ P = MU ÷ P 1 1 2 2 ● Consumer Axioms (accepted truths) 1. consumers rank their preferences based on what they think is best 2. preferences are transitive a. if A > B and B > C, then A > C 3. More is preferred to less ● Marginal Rate of Substitution (MRS): rate at which a consumer is willing to trade one good for another ● an Indifference Curve (IC) shows a consumer's’ willingness to trade goods ● a Budget Line (BL) shows the ability to trade goods by showing budget constraints ○ slope of the BL is the market’s tradeoff ratio between two goods ● the consumer’s indifference curve is tangent to the budget line (they touch where the slope is the same) ○ Where they intersect is the consumer’s equilibrium Week 5: Production, Costs (Exam #2, Homework #3) ● To understand supply, we have to understand profits. → To understand profits, we have to understand revenue. → To understand revenue, we have to understand costs. → To understand costs, we have to understand production. ● Production has two kinds of input: 1. fixed → remains the same during the production process 2. variable → changes throughout the production process; changes the amount of output ○ in the long run, all inputs become variable Ex: at the start, the land you work on can be considered a fixed input, but at some point you might want to buy more land, causing it to become a variable input ● Law of Diminishing Marginal Productivity (MP): as you add variable inputs to a fixed input, marginal productivity will eventually begin to diminish ● MP is the ratio between total productivity (TP) and variable inputs (VI) ○ MP = (change in TP) ÷(change in VI) ● a Production Curve shows the relationship between input and output ● a Cost Curve shows the relationship between the costs of inputs and outputs ○ Total Variable Cost (TVC) curve shows costs of variable inputs ○ Total Fixed Cost (TFC) curve shows costs of fixed inputs; parallel to the xaxis ○ Total Cost (TC) curve represents all of the costs (TVC + TFC); parallel to the TVC curve, but starts at TFC curve instead of 0 ● Marginal Cost (MC) mirrors MP → if production goes up, costs go down (and vice versa) ● whatever is “marginal” influences the rest of the graph ○ MC influences average variable (AVC) and average total cost (ATC) curves ○ MP influences average product (AP) ● the distance between AVC and ATC on a graph is the average fixed cost (AFC). ○ the area between the two is the TFC ○ area under AVC is the TVC Week 6: Costs, Profits, Perfect Competition (Exam #2, Homework #3) ● the bulk of American productivity is for profit ○ without incentives, the economy won’t be productive ● Kinds of Production Markets: ○ Monopoly no competition ○ Perfect Competition (PC) endless competition ○ Oligopoly very few large firms ○ Monopolistic Competition (MC) many producers selling imperfect substitutes ● Criteria for PC 1. lots of buyers and sellers so nobody can control the price 2. product must be homogeneous (can’t tell the difference between products) 3. knowledge of price and availability 4. mobility of resources (freedom of entry and exit of the market) ● the optimal output level for producers is when MR = MC (Long Run Equilibrium (LRE) → zero economic profit (ZEP)) ● if producers are producing when revenue is less than their costs, they have to determine if they should shut down or operate by comparing their losses in each scenario ○ FC must be paid no matter what; the comparison is made between VC and profits Week 7/8: Monopolies, Imperfect Competition (Exam #2, Homework #4) ● the government imposes a price support on companies to “help” producers make profit, but it usually causes a surplus that the government ends up storing and/or selling to other countries ● it’s a myth that monopolies charge “whatever” → consumers restrict what a monopoly charges ● Monopolies vs. PC ○ PC: ZEP, allocative efficiency (supply = demand), technological efficiency (MC=ATC) ○ Monopolies: not allocatively efficient, not technologically efficient, ZEP is possible, but not likely (due to the lack of freedom in entry and exit) ● for a natural monopoly, the firm has to have a large share of the market in order for prices to be low ● Most American industries produce under MC ○ relaxes the homogeneity and producers will charge what consumers will pay ○ Advertising exists because of MC ● Oligopolies have similar prices and similar products with very few firms Ex:American auto industries ● Theories about Oligopolies “cheating the system”: ○ Cartel Theory: instead of competing, industries act as a monopoly and agree on a quota ○ Competitive Theory: firms have the same costs, thus they can only produce similarly priced products ○ Dominant Firm Theory: a dominant firm sets a price and the other firms follow suit because they’re less influential on the market Week 9: Labor Markets, Minimum Wages, Benjamin Powell (Exam #3, Homework #5) ● all firms are a part of two markets → producers can’t create output without buying input ● the higher the wage rate, the more willing people are to work Ex: If you were offered a job that paid $8/hr and another that offered $10/hr, which would you choose? ○ however, the more producers have to pay to hire people, the less they’ll hire ● a worker’s economic rent/wage surplus is the area above the graph and below the current wage → worker is earning more than what they’re originally willing ● Requirements for Input Markets: 1. derived demand 2. jointly determined with capital ● Marginal Revenue Product (MRP) is the marginal revenue (MR) generated by production per worker ○ MRP = demand ○ who gets hired is based on where supply and demand intersect ○ in a PC market, MR is constant; in a monopoly, MR is not ● supply curves for labor are always positive → if it crosses the xaxis, that means people would be willing to work for nothing (would you?) ● if a wage is higher than the equilibrium wage, suppliers won’t afford to pay their workers and unemployment will occur; if a wage is lower than the equilibrium wage, not enough workers will work ● Minimum wage laws do nothing to address poverty ● To find the gains and losses of a minimum wage on a market: ○ gains = (# new workers)(new wage old wage) ○ losses = (old # workers new # workers)(old wage) ● Antisweatshop movements do more hurt than help to third world countries ○ To help workers in thirdworld countries, activists should buy the products! Week 10: Discrimination, Poverty (Exam #3, Homework #5) ● statistical discrimination: when a consumer has to pay a different price than another based on statistics ● What really causes the 77¢ for every $1 Wage Problem: 1. job type → men are more likely to work a higherpaying STEM job than women 2. job consistency → women often leave the workforce for maternity leave 3. geographic mobility → women drop everything to follow their spouses (Trailing Spouse Syndrome) 4. “channeling” → certain jobs are made for certain genders ● the Comparable Worth Doctrine (compares and scores jobs based on skills, conditions, demand, and impact) interferes with the labor market and can cause shortages in some markets and surpluses in others ● number of people in poverty has increased, but the percentage of poverty has decreased? → this is caused by an overall population increase ○ if we look at consumption (including benefits like food stamps) instead of income, poverty rates are lower ● not all of those who live in poverty live that way their whole lives Week 11/12: Social Security, Public Goods, NonMarket Decision Making (Exam #3, Homework #6) ● know the difference between equal vs. equitable ○ equitable = fair; equal isn’t always fair ● a Lorenz curve shows income distribution between households within a society ○ Lorenz curves can be problematic because households vary (some have fewer people working than others) ● the Gini coefficient helps measure the distribution of income ○ closer to 0 = more equal distribution; closer to 1 = less equal distribution ● wealth represents stock; income is a constant flow ● programs for those in poverty: 1. inkind programs: food stamps, housing subsidies, Medicaid, etc. 2. cash programs: Temporary Assistance to Needy Families (TANF), Social Security (SS), etc. ● eligibility for such programs is determined from means (income) and status (how many children) ● formula for negative income tax: W = GI tn * (EI) ○ W → welfare payment; GI = gross income; tn = negative tax rate; EI = earned income; DI = disposable income (W + EI) ● Anybody with a job pays into SS, no matter how much you make ● the SS system is “sick” ○ the government keeps taking money out to pay for other things ● SS needs to be fixed for young people, not old people (there’s no money left for the young people when they retire) ○ to fix: invest in private retirement plans, i.e. the stock market ■ transition problem → if everyone chooses to pay into a private plan instead of SS, what happens to the old people who depend on the young people who are working and pay into SS? ● most goods are actually considered ‘private’ goods ● Criteria for public goods 1. nonrivalrous in consumption → if one person consumes the good, there’s still some left over for others 2. nonexclusionary → no price to exclude people from consuming the good ● public goods are generally provided by the government because in the absence of government, there is no incentive for private industry to provide the good ○ or the government pays private industries to maintain the good ○ often leads to the “Free Rider” problem → people who consume goods without paying for them ● private goods sum across price (horizontally); private goods sum across quantity (vertically) ● collective decision making is “nebulous” → if you know you don’t have to pay for it and you want it, you’ll vote for it ● bargaining costs → the more people you have to convince to vote for something, the more costly it is ○ increase towards unanimity ● external costs → the more people involved in a vote means it’s less costly to make a decision that pleases the “majority” (of who’s present) ○ decrease towards unanimity ● Median Voter Theory: any time the “middle” value is in the election, it wins (it pleases the most people) ● Logrolling involves people “trading” votes so that they get what they want Ex: “if you vote for what I want, I’ll vote for what you want...” ○ measures intensity of preference, which voting regularly doesn’t do Week 13: Taxes, Externalities (Exam #4, Homework #7) ● Kinds of Taxes: 1. payroll paid by everyone who works 2. income in addition to payroll taxes; not everyone pays 3. property usually a flat fee 4. sales a. ad valorem based on value (percentage) b. excise fixed (dollar amount) 5. savings “unearned income”; interest on savings 6. tariff tax on imported goods 7. corporate profits 8. death ● Types of Income Tax Rates: 1. proportional → flat rate (percentage) for everyone 2. progressive → as the base increases, the rate increases a. the higher the marginal tax rate, the lower the incentive there is to work 3. regressive → as the base increases, the rate decreases 4. poll → not tied to income; a flat amount (different than a rate) ● a statutory burden is a tax that producers have to pay by law ● an economic burden depends on elasticity, and it affects both consumers and producers ● externalities (AKA “3rd party” effect, “spillover” effect) occur when a third party affects a tradeoff between buyer and seller ○ it’s usually caused by a lack of property rights ● market wealth/welfare: CS + PS ● taxes cause a portion of the CS and PS to go to the government ○ the area left over between the three is called a deadweight loss (DWL) of the market’s wealth ■ the goal is to keep the DWL as low as possible ● taxes/regulations don’t prevent the producer from doing something, it only reduces their incentive to do it. ● only way a supply and demand graph can be socially optimal is if the supply curve represents all of the costs and the demand curve represents all of the benefits ○ a positive externality occurs when the demand curve is not “true”; producers stop short of the efficient amount ○ a negative externality occurs when the supply curve is not “true”; causes producers to overproduce from the efficient amount Week 14/15: Trade (Exam #4, Homework #7, Homework #8) ● any time there are differences in opportunity costs, there are gains to be made from trade → trade only happens if a country believes they’re better off after the trade (incentives!) ● Comparative advantage: compares the relative efficiency of each company (what costs less to make in each country) ● Absolute advantage: when a country can more efficiently produce a product than another ● tariffs harm domestic consumers but benefit domestic producers ● the bigger the tariff applied to imports, the bigger the DWL to the economy, but imposing a quota instead of a tariff is even more costly to the economy ● If the world price of a good is lower than its domestic equilibrium price, the country will import a quantity of the good equal to the difference between the quantity demanded domestically and the quantity supplied domestically
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